Household Risk Management

Abstract

Households’ insurance against adverse shocks to income, expenditures for health and other spending needs, and the value of assets (that is, household risk management) is limited and at times completely absent, in particular for poor households. We explain this basic pattern in household insurance in an innite horizon model in which households have access to complete markets subject to collateral constraints resulting in a trade-o between risk management concerns and the nancing needs for consumption and durable goods purchases. Insurance, which is typically thought of as trade across states, is linked to intertemporal trade, that is, consumption smoothing and nancing, when households’ promises to pay are restricted by limited enforcement. Household risk management is increasing in household net worth and income, under quite general conditions, in economies with income risk and durable goods price risk. Household risk management is precautionary in the sense that an increase in uncertainty increases risk management; remarkably, risk aversion is sucient for this result and no assumptions on prudence are required.